TEXT-S&P rates Alon USA Energy Inc

Overview
-- Alon USA Energy Inc. is issuing a $450 million covenant light senior
secured term loan B to refinance its existing $425 million term loan due in
2013.
-- We expect that Alon will redeem a portion of the new term loan and the
Alon Krotz Springs senior secured notes with proceeds from a planned initial
public offering (IPO) of Alon USA Partners LP as a variable master limited
partnership (MLP). We also expect the MLP will assume about $250 million of
the term loan.
-- We are affirming our corporate credit ratings on Alon USA and Alon
Krotz Springs, and assigning a 'B+' rating to the new term loan with a '2'
recovery. At the same time we are placing the issue rating on Credit Watch
with negative implications, reflecting the risk that the issue rating could
fall to 'B' if the MLP assumes a portion of the debt.
Rating Action
On Oct. 22, 2012, Standard & Poor's Ratings Services assigned our 'B+' issue
rating and '2' recovery rating, indicating our expectation of a substantial
(70% to 90%) recovery if a payment default occurs, to Alon USA Energy Inc.'s
$450 million senior secured term loan B issuance. At the same time we placed
the issue rating on CreditWatch with negative implications to reflect the
possibility that we will lower the rating to 'B' on the portion of the term
loan assumed by the MLP in conjunction with the IPO. We also affirmed our 'B'
corporate credit ratings on Alon and Alon Refining Krotz Springs Inc. (ARKS).
The rating outlook is stable.
Rationale
The rating on Alon reflects its "vulnerable" business risk profile and its
"aggressive" financial risk profile. Standard & Poor's takes a consolidated
analytical approach to Alon, including results from the Krotz Springs refinery
and its asphalt and retail businesses. The ratings also incorporate Alon
Israel Oil Co. Ltd.'s support for Alon.
Our assignment of a 'B+' issue rating to the term loan reflects our view that
the initial refinancing is credit neutral. It increases debt by about $25
million but improves liquidity by addressing near-term maturities. The initial
credit profile is also supported by a 75% cash flow sweep that can accelerate
deleveraging until the term loan is reduced to $250 million. We expect that
recent debt reduction and higher EBITDA will significantly reduce adjusted
leverage to near 2x for 2012 and 2013. We believe the main drivers of improved
earnings are stronger margins at the Big Spring and Krotz Springs refineries
resulting from crude discounts and better operational performance.
However, our placement of the issue rating on CreditWatch with negative
implications on reflects potential risks to lenders based on the company's
announced MLP plans, which could reduce future recovery prospects as described
in the recovery section below. The company plans to launch the IPO of Alon USA
Partners LP as a variable MLP owning the Big Springs refinery. If executed as
planned, we expect that net proceeds would be used to pay down debt at Alon
and ARKS, the MLP would assume $250 million of the term loan, and the cash
flow sweep would end. While we view the significant debt reduction positively,
we believe MLP distribution policies can weigh on financial risk because unit
holders will expect quarterly distributions from available cash flow. In
general, we believe this leaves an MLP more vulnerable to liquidity strains
than a corporate issuer that can retain a cash cushion. MLPs rely much more
than corporations on outside sources of capital to fund growth spending and
are more vulnerable to frozen capital markets. Security interests for lenders
to the $250 million term loan will also become limited to the assets of Alon
USA Partners LP and its subsidiaries, and they will face single asset risk, no
longer benefiting from the cash flows and diversity that the retail business
and other refineries currently provide at the Alon USA Energy Inc. level.
Despite these negatives, we believe the strength of the Big Spring asset will
result in stronger MLP credit metrics over the short term, helping to mitigate
the weaknesses. Currently, margins at the Big Spring facility are benefiting
from strong distillate pricing and discounts on West Texas intermediate-priced
crudes. High utilization also helps to lower unit operating costs per barrel,
increasing net margins. We currently believe favorable refining conditions
will persist at Big Spring through 2013, and under the assumed IPO terms, we
expect adjusted MLP debt to EBITDA to be below 2x for 2013. However, we
recognize that financial performance will be highly volatile, depending on
industry conditions. A return to midcycle crack spreads or a moderation in
geographic basis advantages could raise our leverage ratio calculation above
2.5x longer term. For more analysis of the company's assets and operations,
please see the research update published July 31, 2012.
Liquidity
Liquidity is "adequate", with sources over uses of more than 2x. We estimate
about $335 million in current sources consisting of about $50 million in cash,
about $215 million in funds from operations, about $40 million of assumed
credit line availability, and about $30 million from positive changes to
working capital. We assume uses of about $135 million consisting of capital
spending (more than $100 million), distributions (however, after the MLP IPO
we expect substantially all available cash will be distributed, and nominal
debt amortization. While the sources and uses point to a "strong" descriptor,
more qualitative factors--such as capital market access and the refining
sector's highly volatile cash flows--limit our liquidity descriptor to
"adequate".
Certain other factors also enhance the company's liquidity. Primarily,
financial support from parent Alon Israel Oil, either through equity infusion
or letter-of-credit support, has improved the companies' liquidity. Multiyear
working capital financing agreements with J. Aron & Co. support operations by
reducing working capital requirements at all three refineries. In the past,
mezzanine financing and ongoing equity sales have also provided additional
liquidity.
Recovery analysis
Alon's new $450 million term loan due 2018 and ARKS's $216.5 million senior
secured notes due 2014 both have an issue rating of 'B+' (one notch higher
than their corporate credit ratings) and a recovery rating of '2', indicating
our expectation for substantial (70% to 90%) recovery in the event of a
default.
After the IPO, the security for lenders on the portion of the term loan
assumed by the MLP will be reduced. Although we currently view the Big Springs
refinery as the strongest asset in the Alon portfolio in terms of contribution
to earnings, we believe $250 million of assumed debt at the MLP could
potentially have a recovery rating of '3' (50%-70%) in the event of default
based on our current recovery valuation of the asset. For refineries that we
expect to remain in operation, we generally value the fixed refinery assets at
a multiple of $2,000 to $3,000 per barrel per day (bpd) of throughput
capacity, depending on our assessment of the relative quality of the assets.
These multiples are based on historical transaction prices and are adjusted
for inflation to exclude working-capital assets and to reflect industry
distress conditions that we believe are consistent with a default scenario.
For the Big Spring refinery, we applied a value of $2,200 per bpd, which,
after accounting for bankruptcy-related administrative expenses and
prepetition interest, would yield a recovery rating of '3', indicating our
expectation of a meaningful (50% to 70%) recovery in the event of a payment
default. The lower recovery rating would leave the issue rating a notch lower
at 'B', but a change in the debt amount or to our valuation assumption could
materially change the recovery rating.
Outlook
The stable outlook reflects our expectation that Alon's financial measures
will improve, with debt to EBITDA leverage of about 2x over the next two years
as a result of debt repayment and increased EBITDA driven by access to
discounted crude supply. We could lower the rating if the leverage increases
beyond our expectations, operating problems occur at the refinery business, or
lower margins lead us to expect sustained debt to EBITDA approaching 4x. Given
the inherent volatility and unpredictability of the refining industry, an
upgrade is unlikely at this time. Furthermore, we believe the planned MLP
structure will reduce business diversity and is likely to increase risks in
the MLP's financial profile, limiting its upgrade potential until a track
record as an MLP is established. However, we could consider it if the company
can establish a track record of strong operational performance, if we become
convinced that the partnership will benefit from favorable crude and product
differentials on a more permanent basis such that we expect midcycle margins
that will yield a sustainable debt to EBITDA ratio below 2x, or if it can
reduce business risk by further diversifying its assets.
Related Criteria And Research
-- Key Credit Factors: Criteria For Rating The Global Midstream Energy
Industry, April 18, 2012
-- Key Credit Factors: Criteria For Rating The Global Oil Refining
Industry, Nov. 28, 2011
-- Methodology And Assumptions: Liquidity Descriptors For Global
Corporate Issuers, Sept. 28, 2011
-- General Criteria: Principles Of Credit Ratings, Feb. 16, 2011
-- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded,
May 27, 2009
-- Hybrid Capital Handbook: September 2008 Edition, Sept. 15, 2008
-- 2008 Corporate Ratings Criteria: Analytical Methodology, April 15, 2008
Ratings List
Ratings Affirmed
Alon USA Energy Inc.
Alon Refining Krotz Springs Inc.
Corporate Credit Rating B/Stable/--
Alon USA Energy Inc.
Senior Secured B+
Recovery Rating 2
Alon Refining Krotz Springs Inc.
Senior Secured B+
Recovery Rating 2
New Rating; CreditWatch/Outlook Action
Alon USA Energy Inc.
Senior Secured
US$450 mil term B bank ln due 2018 B+/Watch Neg
Recovery Rating 2

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